Introduction

An input tax deduction may be claimed when value added tax (VAT) is incurred on goods and services acquired for the purpose of consumption, use or supply in the course of making taxable supplies. A vendor's entitlement to claim input tax deductions in respect of expenses incurred is generally not disputed where a vendor makes wholly taxable supplies. Therefore, VAT is not generally a large component of a business's cost base, as most VAT-registered businesses will be entitled to claim a credit or refund of VAT paid to the extent that they conduct an enterprise that makes taxable supplies.

However, there has been a great deal of uncertainty surrounding the claiming of VAT input credits, particularly where mixed taxable and non-taxable supplies are made and in the context of expenses relating to corporate actions. This uncertainty regarding the deductibility of input tax credits in certain instances has created a VAT risk for many vendors. This update provides an overview of the differing views held by the courts and the South African Revenue Service (SARS) and highlights the relevant considerations when determining whether the VAT incurred for purposes of certain corporate actions may qualify as an input tax deduction.

Key issues

In Income Tax Case 1744 65 SATC 154 (ITC 1744) the appellant – a manufacturer of steel shipping containers – employed the services of a company specialising in the venture capital markets to undertake two share placings in order to raise capital to manufacture containers. The appellant claimed the VAT incurred on the company's fees as an input tax deduction on the basis that it would not have been in a position to manufacture the shipping containers had it not raised the capital. The appellant argued that the services were therefore acquired for the purpose of consumption, use or supply in the course of making taxable supplies. However, the court found against the appellant and, relying on a judgment handed down by the European Court of Justice (ECJ) in 1995, held that a direct and immediate link is required between acquisition of the service and the making of taxable supplies. The court held that the immediate purpose of incurring the expense was to make an exempt supply (ie, the issue of the shares) and regarded the ultimate purpose as irrelevant.

In the subsequent case of Commissioner for SARS v De Beers [2012] ZASCA 103 (June 12 2012), which was heard by the Supreme Court of Appeal, the respondent, De Beers Consolidated Mines Ltd (DBCM), required the services of independent financial advisers to advise its board on whether a proposed restructuring transaction was fair and reasonable. DBCM was legally obliged to employ the independent financial advisers' services in order to protect the rights and interests of independent DBCM unit holders. DBCM claimed input tax deductions in respect of the services acquired – however, the claim was rejected by SARS.

The Tax Court, which first heard the matter, found in favour of DBCM and dispelled the reasoning in ITC 1744 by favouring a more generous commercial approach, requiring only "some link" and not a "direct link" between the expense incurred and the making of taxable supplies before a deduction can be made. However, the Tax Court's decision was set aside when the case was taken on appeal to the Supreme Court of Appeal. The supreme court in the De Beers case adopted a more restrictive approach to the allowing of VAT input credits, and in applying the 'direct and immediate link' test, dismissed the contention that where a vendor wholly carries on taxable activities, that all of its expenses, including those relating to corporate actions that may arise, are attributable to such taxable activities. In the De Beers case, the Supreme Court of Appeal chose to follow a restrictive approach in keeping with earlier EU judgments and with ITC 1744, despite the fact that subsequent ECJ judgments have developed differently.

Input tax

The definition of input tax as set out in Section 1 of the VAT Act (89/1991) requires that goods or services be acquired for the purpose of consumption, use or supply in the course of making taxable supplies. Various South African judgments dealing with the phrase 'in the course of' indicate that in order to claim an input tax deduction, there must be some relationship between the consumption or use of the services or goods and the making of taxable supplies. These judgments have not required a direct or immediate link as was required by the Tax Court in ITC 1744, and subsequently by the Supreme Court of Appeal in the De Beers case. South African law does not have a 'direct link' requirement. Its requirement is that goods or services have been acquired for the "purpose of consumption, use or supply in the course of making taxable supplies". It is also important to note that the legislature does not use the phrase "directly in connection with" (as is used in Section 11(2)(l) of the VAT act, for example), which would have required a close and uninterrupted relationship.

International developments

Developments within the European Union in cases such as Kretztechnik AG v Finanzamt (Case C-465/03 2005) and Skatteverket v AB SKF (Case C-29/08 2008) also indicate a shift away from a restrictive application of the 'direct and immediate link' test to a more generous approach, requiring only that there be a link to the overall business activities of a taxpayer. From the De Beers judgment, it is clear that the South African courts disregard developments in other jurisdictions.

The De Beers judgment, having established certain guidelines and principles regarding the claiming of input tax for VAT purposes, seems to have created more questions than answers, requiring taxpayers to defend input tax deductions on costs that they did not have to defend before.

Although the De Beers judgment casts light on the South African approach to deductibility of input tax, the debate surrounding this issue persists. The Supreme Court of Appeal in De Beers declined to follow certain international precedents developing along more generous lines, and it therefore seems that both SARS and the South African courts will continue to take a more restrictive approach.

The Tax Court's judgment in the De Beers case – although it was overturned by the Supreme Court of Appeal – took international developments into account and was also more aligned with the wording of the VAT Act, thus giving effect to the neutrality principle of VAT.

Comment

It is submitted that the approach adopted by the Supreme Court of Appeal in the De Beers judgment conflicts with the neutrality principle of VAT, and it is expected that application of the approach taken by the Supreme Court of Appeal will result in businesses carrying a VAT cost for legitimate business expenses incurred in the course of – though not directly and immediately linked to – their taxable activities. The question of whether a vendor will be entitled to claim input tax deductions for expenses relating to corporate actions should therefore be carefully considered on a case-by-case basis, and in the context of its enterprise activities.

As mentioned above, the Supreme Court of Appeal in the De Beers case dismissed the contention that where a vendor carries on wholly taxable activities, all of its expenses are attributable to such taxable activities. This approach seems to be overly restrictive and it is likely that the principles adopted by the Supreme Court of Appeal in the De Beers case will be challenged by many South African vendors.

For further information on this topic please contact Varusha Moodaley at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email (varusha.moodaley@cdhlegal.com). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.

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